Seal the deal: how to draw up a contract

By David Wilson

June 21, 2010 — 4.35pm

Ever been stuck in a sticky business partnership? Relations can get especially tricky if you work together on a kinda-sorta basis lacking legal underpinning, as well you may.

A breezy "mateship" approach is appealing - nobody likes to look uptight. Our laissez-faire free market economy's talent for coasting along may cement complacency. But even in the no-worries 'Lucky Country', an entrepreneur must be strategically poised. What happens, say, if your partner cuts up nasty?

Drawing up a contract is the best way to avoid messy grey areas.

"Most people fail to realise that the best partnership agreements are mainly about dissolution and remedies involving disputes," says veteran business analyst Rob Frankel. "Very few people have issues about how to split revenue, which is usually clearly defined," Frankel adds. "It's how to split from each other that presents the biggest obstacles."

The absence of a written agreement can bring down a business, according to Frankel. He tells the story of two partners who relied on an unspoken understanding. When one slacked off and stopped doing his job, the other offered to buy him out or be bought out. The first partner rejected both options, apparently holding out for a higher price.

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Deadlock set in. The other partner then stopped performing too, let the business die of attrition, and re-built a similar business from scratch. "There was no other solution," Frankel says.

The only way to block the threat of a complicated divorce like that is to draw up a contract. Learn the secrets of producing one that covers the angles and has grunt. Get rid of those messy grey areas.

Pre-nup: the six secrets of writing a partnership contract

1. Divide roles

Clarify who is responsible for what, suggests business attorney and small business coach, Traci Ellis. If everyone has clearly defined roles and responsibilities, that will save many headaches.

2. Allot profit

Are profits split according to ownership or some other allocation? Work it out. "This is important," Ellis says.

3. Account for catastrophe

The agreement should include "buy-sell" provisions that spell out what happens in the case of "triggering events". Think death, divorce, bankruptcy and the like, Ellis says. Fail to prepare and your partner's ex-spouse might grab part-ownership, she warns.

4. Insert a kick-out clause

Critically, the agreement must provide a way to kick out a poorly performing partner, Ellis says. That means covering scenarios such as failing to turn up for “x” number of consecutive days - other than holidays or leave - and failing to stay "consistently engaged". Then, "buyout terms" come into play. Think, for instance, about how the venture will be valued. If you own half and it is worth $100k, you are entitled to $50k. Define how your share will be paid: Lump sum? Or an up-front payment and the balance over time?

5. Mediate against meltdown

Embed a dispute resolution clause, suggests Shane Fischer, an attorney who drafts business contracts and tackles breaches. The clause should include "mandatory mediation" before a lawsuit can be filed. The measure forces business partners to work out their differences without costly litigation - a victory for all sides.

6. Enlist a pair of professional eyes

However thorough you are, get the contract reviewed by a lawyer, says Fischer. "This is because an attorney can remain objective, and can point out minor errors in your proposed partnership that can lead to major problems later," Fischer says. Pick a lawyer experienced in business formation, he suggests. "It will be money well spent."